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Monday, November 28, 2011

How Alexander Del Mar (Who?) Scooped Milton Friedman

Milton Friedman famously proposed in the 1960s that rather than having a central bank pursue a discretionary monetary policy, and thus in a world of time lags and policy uncertainties end up contributing to economic booms and busts, it would be better if the central bank just managed the money supply to grow at a constant rate of 3% per year. Unknown to Friedman, Alexander Del Mar made this same proposal in 1886.

Which raises the question, "Who the heck was Alexander Del Mar?" George S. Tavlas gives an lively and readable overview in "The Money Man" in the November/December issue of the American Interest.

Those who have heard of Del Mar make some striking comments about him. According to Tavlas, James Tobin called him "one of the most important U.S. monetary economists of the 19th century," while Robert Mundell called him “too hot to handle.” Among other professional accomplishments, Del mar was a co-founder in 1865 of the New York Social Science Review: Devoted to Political Economy and Statistics, often thought of as one of the first economics journals published in the United States. He was also the first director of the U.S. Bureau of Statistics in 1866--which later evolved into the U.S. Department of Commerce.

But among students of monetary history, Del Mar is best-known for having challenged the prevailing view of his time that money needed to be something with intrinsic value, like gold or silver. Tavlas explains:

"He [Del Mar] referred to the example of the ancient states of Ionia, Byzantium, Sparta and Athens. As far back as the 10th century BCE, these states created huge discs of sheet iron or bronze that had no practical value but served as common measures of value against which all exchanges of goods could take place. In other words, Del Mar realized that money originated notto serve as a medium of payment in purchases (these discs were too heavy and bulky to be exchanged for goods), but to serve as a measure of value, or what economists call “a unit of account.” By establishing common units of account, early societies enabled the direct exchange of goods against goods to take place without the need for a physical object to be interposed as a medium of exchange. Del Mar saw that the existence of a unit of account is a necessary condition for the emergence of a full-fledged money economy ..."

"The observations—first, that the function of money is to measure value rather than itself be value, and, second, that in advanced societies the state determines what is used as money—allowed Del Mar to develop a further insight. Since money measures value, if the state creates too much money, then it can cause an inflation of prices. In such a circumstance, the valuableness of money diminishes because its ability to perform its primary function degrades—that of measuring the value of one good against another. Money, he argued, is a measure like a yardstick."

Thinking of money as a unit of account for transactions and as a yardstick of value is standard fare in modern economics, but it was radical in Del Mar's time. However, these ideas are what led Del Mar to propose his rule that the government should guarantee that the supply of money would rise at 3% per year--which was Del Mar's estimate of the annual increase in the supply of goods and services each year. His proposal was well-timed, since in 1886 the U.S. economy was living through a period of ongoing deflation with periodic severe recessions. But his advice was ignored.

Why is Del Mar so little-known? Tavlas makes a case that part of the reason may be that Del Mar was Jewis, and overt anti-Semitism was common at the time among many economists and universities. Another reason is that, when it came to monetary theory, Del Mar was too far ahead of his time.